History Repeats Itself
Research for Online Investors

by John Dalt

10/14/10

Is history about to repeat itself?  The Federal Reserve is widely expected to pump more money into treasuries next month.  The goal is to push interest rates lower on investments.  This punishes savers and encourages riskier investments.  The most abused segment of the population is the elderly, as they have a lifetime of savings that are concentrated in “safe” fixed term instruments.

What assets will see inflows of cash if savers leave fixed term?  Equities in companies (stocks), real estate, and private businesses would benefit.  The benefit to the economy is obvious with each of these shifts in money.

Higher stock prices push company valuations up, creating stronger balance sheets.  Money chasing real estate would be a welcome relief after the last three years.  Small businesses having additional investment would allow them to expand and produce jobs.

The other economic benefit to the economy is increased consumer spending.  When money gets pulled out of fixed investments, some will naturally end up buying a new car or television.  Maybe a home remodel!  Why not enjoy the money, some will ask.  They may think, ‘We are not making any return on it in the bank.’

The market was surprised by economic reports this morning, and the Fed should pay attention.  Initial jobless claims were up over last week.  The numbers were down last week, but bounced back higher than two weeks ago.  Traders and investors saw this as confirmation (and reinforcement) the Fed would pop the cork on quantitative easing.  “We need more money” seemed to be the shout from the trading floors.

Wait a minute; the Producer Price Index (PPI) was up 0.40% over August.  What does that mean?  Inflation is building in the pipeline.  PPI tells us the selling price of goods received by domestic producers of goods and services.  This follows the same rate for July.  The market expected PPI to drop to only 0.10%.

If you string 0.40% together for a year, we end up with inflation of 4.8%.  Compounded year after year, the U.S. ends up in real trouble.  The Fed will see this number and should ask “Do we want to push inflation up that fast?”  2% inflation is widely understood to be the Fed’s target.  A double or triple when it gets out of control should raise concerns with every Keynesian believer.

There are voices of caution on the Fed.  Kansas City Federal Reserve Bank President Thomas Hoenig has been the most consistent against expanding the Fed’s balance sheet to spur economic growth.  He believes the Fed should raise its short-term target interest rate to 1 percent.  We reported this on Aug. 11 in Fed Fumbles.

Hoenig also rejects the idea of raising the Fed's informal inflation target above 2 percent.  "'I have to tell you it (QEII) horrifies me. It assumes you can fine-tune things like interest rates.  I have never agreed to an informal inflation target.  Two percent inflation over a generation is a big impact.”

Dallas Fed President Richard Fisher sees the unintended consequences of quantitative easing II.  He addressed the Minneapolis Economics Club last week.  “ If others cotton to the view that the Fed is eager to "open the spigots," might this not add to the uncertainty already created by the fiscal incontinence of Congress and the regulatory and rule-making 'excesses' about which businesses now complain?  Driving down bond yields might force increased pension contributions from corporations and state and local governments, decreasing the deployment of monies toward job maintenance in the public sector.”

photo courtesy Bloomberg

If the decision is to deploy more quantitative easing, it will be because of “Helicopter Ben” Bernanke and others like him on the Federal Open Market Committee (FOMC).  He has New York Fed President William Dudley backing him, “Fed action is likely to be warranted unless the economic outlook evolves in a way that makes me more confident that we will see better outcomes for both employment and inflation before too long…the Fed will keep pumping, until it sees the proverbial whites-of-their-eyes, as it relates to inflation, and job growth.”

Our only comment, 'Ben and Billy' you have inflation now, you still have high unemployment. Get ready for interest rates to get away from you and it is back to all the gaiety and excitement of the 1970’s under Jimmy Carter. Make sure you look up “Stagflation” and the “Misery Index.” You will want to be well versed in the meaning of each.

Do you think any of them wonder why gold and silver keep setting new highs?  We hope the Federal Reserve will back away from QEII, or severely limit it.  This will disappoint the stock market and likely cause a hard sell-off.  The long term unintended consequences of more money in the system could be much worse.

To the mailbag:
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Today’s quote:
Those who cannot remember the past are condemned to repeat it.---George Sanayana, Poet and philosopher in ‘Reason in Common Sense’ 1905

The information presented in this newsletter is based on generally available news releases, corporate filings, current events, interviews and the editor’s opinions.  It may contain errors and you should not make investment decisions based solely on what you believe you have read here.  Do your own research, it is your money.  If you lose it, it is your responsibility, not ours or your grandmothers!  The editor may or may not have a position in any securities discussed.  The editor may have held a position in a security earlier, or in the future.

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